Continuation gap: Meaning, Criticisms & Real-World Uses

What Is Continuation Gap?

A continuation gap is a type of price gap that appears on a financial instrument's price chart during an established trend, indicating that the existing directional movement is likely to persist. These gaps, also known as "runaway gaps" or "measuring gaps," suggest strong underlying momentum and market sentiment that causes prices to skip over certain levels with little or no trading activity in between. Continuation gaps are a key concept within technical analysis, as they provide visual cues that reinforce the prevailing market direction. They typically occur when a significant number of traders, who initially missed the start of a major price move, decide to enter the market, leading to a sudden surge in buying or selling pressure.¹²,¹¹

History and Origin

The study of price gaps in financial markets dates back to the early days of chart patterns and technical analysis. Pioneers in charting observed these "holes" in price graphs and began to assign significance to their occurrence. The concept of gaps, including the continuation gap, was formalized and discussed in classic works on technical analysis, which sought to interpret price behavior through visual patterns. Gaps are understood to result from extraordinary buying or selling interest that often develops when the market is closed, such as after an unexpected earnings report or significant news. This imbalance between supply and demand can cause the next trading session's opening price to be significantly higher or lower than the previous day's close, creating the visible gap.¹⁰ While the observation of price gaps has a long history, academic research into their behavior and whether they represent true market anomalies has continued to evolve. Studies have examined price gap anomalies in various markets, including the US stock market, analyzing their presence and potential for profitability.⁹

Key Takeaways

A continuation gap appears within an existing price trend, signaling that the trend is likely to persist.
These gaps are often referred to as "runaway gaps" or "measuring gaps" due to their tendency to occur around the midpoint of a price move.
They are characterized by a sudden jump in price where no trading occurs between the previous close and the new open, reflecting strong momentum.
Continuation gaps reinforce the prevailing market trend and can be used by traders to confirm the strength of the trend.
Identifying these gaps often involves analyzing volume and the overall market context.

Formula and Calculation

While there isn't a specific formula to "calculate" a continuation gap, its appearance can be interpreted to project potential price targets. Technical analysts often use the "measuring" aspect of the continuation gap for this purpose. The principle is that a continuation gap tends to occur around the midpoint of a larger price move.

To estimate a potential price target following a continuation gap:

Measure the initial move: Calculate the distance from the beginning of the trend to the point where the continuation gap forms.
Project the distance: Add (for an uptrend) or subtract (for a downtrend) this measured distance from the price level at which the continuation gap occurred.

Let:

( P_{start} ) = Price at the beginning of the trend
( P_{gap_start} ) = Price level where the gap begins (e.g., previous day's close before the gap)
( P_{gap_end} ) = Price level where the gap ends (e.g., current day's open after the gap)
( P_{target} ) = Estimated price target

For an upward trend:

\text{Initial Move} = P_{gap\_start} - P_{start}

P_{target} = P_{gap\_end} + \text{Initial Move}

For a downward trend:

\text{Initial Move} = P_{start} - P_{gap\_start}

P_{target} = P_{gap\_end} - \text{Initial Move}

This projection helps traders anticipate how far the price might move within the existing trend after the gap occurs.

Interpreting the Continuation Gap

Interpreting a continuation gap involves understanding its context within the broader price action and overall market structure. A continuation gap is a strong signal that the prevailing trend has significant momentum and is likely to extend further. For example, in an uptrend, a continuation gap indicates that buyers are aggressively entering the market, pushing prices higher without pausing for trades at intermediate levels. Conversely, in a downtrend, it suggests strong selling pressure.

Traders often look for confirmation of the gap through increased volume accompanying its formation. High volume alongside a continuation gap reinforces the conviction behind the price move, making the signal more reliable. The absence of significant volume, however, might suggest a weaker signal or even indicate a different type of gap, such as a common gap. Analysts consider the "measuring" characteristic of continuation gaps, anticipating that the price movement following the gap will be roughly equal in magnitude to the movement preceding it. This helps in setting potential price targets or assessing the remaining strength of the trend.

Hypothetical Example

Consider a hypothetical stock, "GrowthCo Inc.," trading in a strong bull market. Over the past month, GrowthCo's stock price has steadily risen from $50 to $70. On Tuesday, the stock closes at $70. Overnight, positive news about a new product breakthrough is announced, far exceeding market expectations.

When the market opens on Wednesday, GrowthCo's stock price immediately jumps to $73, creating a visible "gap" on the daily chart between Tuesday's close ($70) and Wednesday's open ($73). No trades occurred between $70 and $73. Throughout Wednesday, the stock continues its upward trajectory, closing at $75.

This is an example of a continuation gap. The gap occurred in the middle of an established uptrend (from $50 to $70), and the price continued to move higher after the gap, confirming the ongoing strength of the trend. A trader using this pattern might interpret the initial $20 move (from $50 to $70) as the first half of the trend. If the gap formed at $70, they might project an additional $20 move from the $73 open, suggesting a potential target of $93 ($73 + $20), indicating strong confidence in the stock's continued ascent. This helps inform their trading strategy.

Practical Applications

Continuation gaps serve several practical applications in financial markets, primarily for traders and investors employing technical analysis to inform their decisions.

Trend Confirmation: The most direct application is to confirm the strength and likely continuation of an existing trend. When a continuation gap appears, it reinforces the conviction behind the current price direction, whether it's an uptrend or a downtrend.⁸
Entry and Exit Points: For traders, these gaps can signal opportune entry and exit points. If a trader is already in a position, a continuation gap confirms their decision and might encourage them to hold the position or even add to it. Those looking to enter the market might use the gap as confirmation before initiating a trade in the direction of the gap.
Price Target Projections: As "measuring gaps," they can help project potential price targets. By measuring the distance of the price move leading up to the gap, traders can estimate a similar move following the gap, providing a rough forecast for where the price might head.
Risk Management: While indicating strength, the formation of a continuation gap can also assist in risk management by helping traders determine appropriate stop-loss levels. A significant retracement that "fills" the gap could signal a weakening of the trend, prompting a review of the position. Price gaps in the U.S. stock market have been subject to academic study to investigate whether they create market inefficiencies that can be exploited for abnormal returns.⁷

Limitations and Criticisms

While continuation gaps are a popular concept in technical analysis, they are subject to several limitations and criticisms, particularly from proponents of the efficient market hypothesis and those who question the predictive power of chart patterns.

One major criticism is the subjective nature of pattern recognition. Different analysts may interpret the same price action differently, leading to inconsistent conclusions. What one trader identifies as a continuation gap, another might dismiss as insignificant market noise or even misinterpret as an exhaustion gap if volume is not properly assessed.

Furthermore, technical analysis, including the interpretation of continuation gaps, relies heavily on historical data and patterns. Critics argue that past performance does not guarantee future results, and market conditions can change rapidly due to unforeseen events, rendering historical patterns less reliable.⁶ Academic research on technical analysis, while mixed, often points out that any potential profitability from such strategies may vanish once transaction costs and biases are accounted for. The "efficient market hypothesis" posits that all available information is already priced into the market, making it impossible to consistently "beat the market" using historical price data.⁵

Moreover, gaps, including continuation gaps, can sometimes be "filled," meaning the price eventually retraces back to the levels where no trading occurred. While some traders believe all gaps eventually get filled, research suggests this is not always true, especially for breakaway and continuation gaps.⁴,³ Waiting for a gap to fill before acting on a trend can lead to missed opportunities or significant losses.

Continuation Gap vs. Common Gap

The distinction between a continuation gap and a common gap is crucial for technical analysts, as each type carries very different implications for future price movements. While both are types of price gaps, their context, typical characteristics, and implications for a trading strategy set them apart.

Feature	Continuation Gap	Common Gap
Context	Occurs within a strong, established trend.	Tends to occur in sideways, range-bound, or quiet markets.
Significance	Signals the likely continuation of the current trend.	Typically has little forecasting significance; often signals temporary price fluctuations.
Volume	Often accompanied by high or increasing volume, reinforcing conviction.	Usually associated with low trading volume.
"Filling" Tendency	Less likely to be "filled" (price reverting to gap).	High probability of being "filled" relatively quickly.
Nomenclature	Also known as runaway gap or measuring gap.	Also known as area gap, pattern gap, or temporary gap.

The primary difference lies in their predictive power. A continuation gap suggests ongoing momentum and offers a basis for projecting further price movement in the direction of the trend. Conversely, a common gap often arises from minor, uneventful market activity, such as a stock going ex-dividend, and is typically filled as prices return to previous levels, offering little insight into a sustained directional move.² Recognizing these distinctions is key to effective chart analysis.

FAQs

What causes a continuation gap?

A continuation gap is typically caused by strong, sudden buying or selling pressure that aligns with an existing trend. This often results from new information, such as unexpected positive or negative news about a company or market, that prompts a significant number of traders to enter or exit positions rapidly, causing the price to jump or drop past previous trading levels.

Are continuation gaps always "filled"?

No, continuation gaps are generally not expected to be "filled" in the same way common gaps are. "Filling the gap" refers to the price moving back to the level where the gap occurred. Because continuation gaps signify strong underlying momentum, the price is more likely to continue in the direction of the gap rather than reversing to close it.¹

How do traders use continuation gaps?

Traders use continuation gaps to confirm the strength of an ongoing market trend and to make decisions about maintaining or adding to existing positions. They also use the "measuring" aspect of these gaps to project potential price targets for the extended trend, which can help in planning their risk management and profit-taking strategies.